Understanding Risk-Adjusted Return: PPFAS Long Term Value Fund

Risk adjusted return is a measure of the risk involved in producing a return. In this post we try and understand this concept using  PPFAS Long Term Value Fund which has recently completed one year in existence.

Kindly note that this is not a review or a recommendation of the fund. I am only using its numbers to understand risk adjusted returns.

Disclosure: I am an investor in this fund.

Investment mandate

It has a unique investment mandate. Some extracts(edited) from the scheme information document.

  • Seek to generate long-term capital growth from an actively managed portfolio primarily of Indian equities and foreign equities and related instruments and debt securities.
  • Buying securities at a discount to intrinsic value will help to create value for  investors. Our investment philosophy is to invest in such value stocks.
  • The Scheme will  evaluate different companies based on their long term prospects (5 years and more) rather than just looking at next quarter or a few quarter’s earnings.
  • Since the objective of the Scheme is to hold the investments in  the companies where the Scheme has invested for the long term, it is essential that the investors in the Scheme have a similar outlook.
  • It is expected that the core equity portfolio of the Scheme will have low churn (portfolio turnover).

The scheme can invest in:

1) Equity and equity related instruments

i. Stocks
ii. Derivatives (exchange traded and over the counter trade)
iii. Index futures, Put Options and Swaps
iv.  Special situation/Arbitrage

2) Debt securities

3) Money Market Instruments

4) Investment in Securitised Debt

5) Investment in Mutual Fund Schemes

6) Foreign Securities (only equity and equity related instruments)

i. ADRs/ GDRs issued by Indian or foreign companies
ii. Equity of overseas companies listed on recognized stock exchanges overseas
iii. Initial and follow-on public offerings for listing at recognized stock exchanges overseas
iv. Derivatives traded on recognized stock exchanges overseas only for hedging and portfolio balancing
with underlying as securities.
v. Units/securities issued by overseas mutual funds or unit trusts registered with overseas regulators and
investing in (a) aforesaid securities, (b) Real Estate Investment Trusts (REITs) listed in recognized stock
exchanges overseas or (c) unlisted overseas securities (not exceeding 10% of their net assets)

Pretty much everything!

Portfolio

This is the portfolio as on 31st May 2014

Current Folio

Here is how the equity/equity related holdings have evolved since inception.

PPFAS LTVF NAV

 

While the other types of holdings have more or less fluctuated around current levels, the equity related holdings have been gradually increased, most likely with an intention to participate in the rally.

While the outperformance with respect to CNX 500 is nothing much to shout about as it is still very early days for the funds, notice that the fluctuations in the NAV movement are lower than that of the benchmark.

Thus, even visually one can conclude that the fund has delivered higher returns with by taking lower risk. Let us try and see if can do better with some numbers.

Returns

Ongoing SIP since an year ago

PPFAS LTVF: 63.32%

CNX 500: 55.02%

Lump sum invested an year ago

PPFAS LTVF: 41.77%

CNX 500: 33.23%

Great! Shall we shut shop and hope for the best?

Not quite. What is the risk associated with these higher returns? Were they obtained by taking more risk? How good is the downside protection of the fund?

These are questions we must train ourselves to ask before we start rejoicing.

1) How correlated is the funds NAV movement with that of the index?

About 96% correlated

Metric which tells us this: R-squared

2) How volatile is the fund when compare with the index?

About 7% less volatile

Metric which tells us this: Beta

3) How much do returns (daily) vary from the average of such returns?

About 0.64% for the fund and about 1% for the benchmark. Meaning the fund deviates from the average lesser than the benchmark, implying lower volatility

Metric which tells us this: Standard deviation

4) How high is the realized return when compared to the return corresponding to the risk taken by the investor?

Assuming 9% corresponds to the return earned with no risk (pre-tax FD rate say), the realized return of the fund is about 30% higher than the return corresponding to the risk taken by the investor.

Metric which tells us this: Jensen's Alpha

Although there are underlying assumptions which are debatable, safe to say that the fund has outperformed the benchmark on risk adjusted basis!

5) Did the returns stem from excess risk or smart investing?

Dividing the return by risk (standard deviation)   allows you to find out if the returns stems from excess risk or smart investing.

Metric which tells us this: Sharpe Ratio

In this context, return refers to the average excess return (fund-return subtracted by risk-free-rate) and risk is the standard deviation.

On this count, the PPFAS fund management team has outperformed the index by about 80%.

So the fund has a higher return/per unit risk than the benchmark.

Thus, the returns stem from smart investing. This is more important that higher returns.

6) What is the probability of a large loss?

PPFAS LTVF has 50% lower probability of a large loss when compared to CNX 500

Metric which tells us this: Sortino Ratio

What do you think is the reason for this?  A well diversified portfolio!

7) How much do returns (daily) vary from a minimum expected return?

Assuming the minimum expected annual return is 15%, the deviation of the fund from this return is 44% lower than the benchmark! That is excellent downside protection

Metric which tells us this: Downside Deviation

8) How stressful has it been for PPFAS LTVT investors?

Metric which tells us this: Ulcer Index! Read more about this here

The Ulcer index is a much more stringent measure of downside protection.

PPFAS LTVF has lowered investor stress by 7% when compared to CNX 500. Not great but not insignificant either.

There are many more measures!! I will however stop here.

All these measures are part of the mutual fund risk and return analyser. Do give it a try.

 

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12 thoughts on “Understanding Risk-Adjusted Return: PPFAS Long Term Value Fund

  1. Mohit Pandey

    Dear Pattu Sir, very well written. I am following the PPFAS from last one year and it has good downside protection. Will be Interesting if we can go back to 2008 and see how PPFAS could have performed.

    Reply
    1. pattu

      Thanks Mohit. If the fund was only investing in stocks, then once could take the current folios and do a back-test. However it is not worth it in my opinion. In 2008, all the funds fell by a large extent and so would this have, had it been around then.

      Reply
  2. Mohit Pandey

    Dear Pattu Sir, very well written. I am following the PPFAS from last one year and it has good downside protection. Will be Interesting if we can go back to 2008 and see how PPFAS could have performed.

    Reply
    1. pattu

      Thanks Mohit. If the fund was only investing in stocks, then once could take the current folios and do a back-test. However it is not worth it in my opinion. In 2008, all the funds fell by a large extent and so would this have, had it been around then.

      Reply
  3. AK Anand

    Futures, put options and Swaps. These are part of the Fund Managers options. No percentage for these is specified. Hope the FM does not over-indulge in these. Ther's nothing to prevent him from these. Lot of fears here. So far so good. But tomorrow, if something were to go wrong,can't he take shelter behind this mandate. Pattu, pls do bring out this possibility, if you think what IS am saying is right.

    Reply
    1. pattu

      Good point, AK. The breakup is not mentioned. Each type of investment has its own form of risk. As long as the movements of each investment is not synchronous, the overall risk will be small.

      Reply
    2. ashal jauhari

      Break up is not given but Arbitrage, derivaties, speical situations etc. are to be considered within Eq. space.

      Reply
  4. AK Anand

    Futures, put options and Swaps. These are part of the Fund Managers options. No percentage for these is specified. Hope the FM does not over-indulge in these. Ther's nothing to prevent him from these. Lot of fears here. So far so good. But tomorrow, if something were to go wrong,can't he take shelter behind this mandate. Pattu, pls do bring out this possibility, if you think what IS am saying is right.

    Reply
    1. pattu

      Good point, AK. The breakup is not mentioned. Each type of investment has its own form of risk. As long as the movements of each investment is not synchronous, the overall risk will be small.

      Reply
    2. ashal jauhari

      Break up is not given but Arbitrage, derivaties, speical situations etc. are to be considered within Eq. space.

      Reply

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